Saturday, January 23, 2010

Social Security Trust Fund: Barrell Lid and not Barrell

In our ongoing debate with Bruce Krasting he seems unable to understand the difference between a Pension Fund like CalPers and Social Security.

In a standard Public Retirement System employers and employees pay into a Pension Fund which then invests the money and then pays out whatever the amount of the contracted pension at retirement. The better the choices and economic luck of the Fund managers the easier it is to pay out the pension when the time comes. That is because the payouts come off the top.

Social Security is different, the payouts come out the bottom. Try this image:

Take two graduated cylinders. The one labeled CALPERS is filled to its ideal level with green. It has two inputs near the top, one which delivers a steady trickle of employer and employee contributions, and the other that delivers ROI on that water. It also has an output which drains off some or all of those earnings to pay retirement checks. If anything is left over retained earnings plus new contributions increases the amount of productive water in the cylinder. But in any event it is the retained water that constitutes most of the volume of the water, moreover for this purpose it is relatively still, all the action is at the surface.

Now examine the cylinder marked Soc Sec TF. For this cylinder the the big input is at the bottom as a flood of receipts from payroll tax flows in. Just above that is another input through which periodic injections of tax on benefits come. On the other side of the cylinder three outputs such water out into channels called benefits, admin and RRB Xchange. Any fluid that doesn't get pumped out right away congeals with a mass floating on top of the rushing stream in and out of the cylinder. That mass is the Trust Fund. But right at the lower edge of the Trust Fund mass and floating with it is another input that represents interest on the dollar value of the floating lid. If inflow continues to exceed outflow it just joins with that surplus and congeals into the floating mass. But in any period in which outflow exceeds inflow a portion of it joins the outflow with only the overage congealing. In this case interest is increasing the mass of the TF even as it contributes a little fluid to the outflow out the bottom.

In the case of CalPers earnings get tapped first, if they drop the put the retained water at risk as some gets tapped off.

In the case of Social Security earnings get tapped second to last, variations in them don't necessarily change anything in the short run, the key is not as in CalPers who much earnings the mass of fluid throws off, but instead how much fluid is flowing into the cylinder, if that flow slackens or if outflow increases then the bottom of the TF mass sinks down towards the output port and eventually that comparatively small stream of interest coming in starts having some of its flow go to the outflow. But the total volume of the interest stream is so relatively small compared to the main flow of tax revenue above and the mass above that there is no perturbation in the system as a whole.